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What Are the Different Types of IRA Accounts?
We all know how important it is to save up for your retirement. One way is to save funds through an employment-based program like a 401(k). Another great tool at your disposal is saving through an Individual Retirement Account (IRA). Let’s look at the different types of IRA accounts and the types of assets to invest in them.
Individual retirement accounts were established to encourage Americans to save up for retirement by providing tax advantages. IRAs are held at a custodian institution, such as a brokerage or a bank, and you can invest in a wide range of assets such as stocks, bonds, and mutual funds (and, as we’ll see later in the article, in precious physical metals). IRAs are governed by the IRS, which decides how much you can contribute to your account and how your funds are taxed.
What are the main pros and cons of an IRA?
Setting up an IRA puts you in control of your retirement savings: You choose what brokerage or bank you wish to use and what assets you want to invest in. Your range of investment choices is much wider than with a workplace retirement plan, and you can make your investment decisions alone or with the help of your financial advisor.
You also decide when and how you get a tax break as the two main types of IRAs — the Roth IRA and the Traditional IRA — work differently in that regard. Best of all, if you qualify for both types in a given year, it opens up for some tax diversification in your retirement portfolio. The different IRA accounts also protect your wealth from creditors as they cannot access these funds.
There are a few disadvantages to IRAs: Your contribution limits are lower than for workplace retirement plans, and while you can choose how and when taxes are deducted, you don’t know what your tax situation will be when you start withdrawing from your IRA, so the choice between an immediate tax break (Traditional IRA) and tax-free income during retirement (Roth IRA) is not an obvious one.
What are the different types of IRAs?
There are 5 different types of IRAs:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Self-Directed IRA
As you are an individual saving for your retirement, you have the choice between two kinds of IRA accounts: the Traditional IRA and the Roth IRA. In addition, your employer may provide a SEP IRA or a SIMPLE IRA. Let’s start with the two kinds of IRA most of our readers will be familiar with.
What is a Traditional IRA?
Introduced in 1974, the Traditional IRA is the “classic” IRA and remains the most popular. It has been described as “the biggest tax break in history.”
How does a Traditional IRA work?
The main feature of the Traditional IRA is the fact that contributions are tax-deductible as long as they meet the IRS’s eligibility requirements as to income, availability of other retirement plans, and filing status. Many retirement savers expect to be in a lower tax bracket upon retirement, so they will be paying less in taxes at the time of withdrawal than at the time they make the contributions.
As long as you have sufficient income to make a contribution to a Traditional IRA, you are eligible to contribute. Any interest, dividends, and capital gains are not subject to taxation until you make a withdrawal; all withdrawals incur federal income tax. There are also some restrictions on withdrawals.
Since the Traditional IRA is a tax-deferred savings plan, the amount of money you have available for investing is larger than with a Roth IRA, which doesn’t allow you to deduct your contributions. With a larger investment amount, you will earn more interest and, potentially, larger dividends, which can be reinvested, resulting in a larger account balance over time.
Advantages of a Traditional IRA
- Contributions are tax-deferred — you don’t pay taxes until you make withdrawals, so you gain an upfront tax break.
- The larger investment amount means you gain an even larger benefit from compound interest, i.e., the interest you earn generates additional interest.
- You can convert your Traditional IRA to a Roth IRA.
Disadvantages of a Traditional IRA
- Since your investments may grow more than with an IRA that’s not tax-deferred, the income taxes you have to pay upon withdrawal may be higher than anticipated.
- Withdrawals are included in your gross income and are therefore subject to federal income tax.
- It can be difficult to use funds from a Traditional IRA in case of emergencies because you need to pay taxes before you can make a withdrawal.
- If you don’t begin withdrawing from your account by April 1 of the calendar year following the year you turn 72, the IRS will confiscate half of the mandatory withdrawal amount.
- There is a 10% early withdrawal penalty if you make a withdrawal when you are under the age of 59 ½ (with some exceptions).
- Since withdrawals are taxable income, your ability to qualify for certain government benefits may be affected if you take them.
What is a Roth IRA?
Named after Senator William Roth, the Roth IRA was introduced as part of the Taxpayer Relief Act of 1997.
This type of IRA account is similar to the Traditional IRA in many ways but with one main difference: Contributions aren’t tax-deductible, but in return, you don’t pay taxes on distributions, including on any growth in the account as long as you meet certain conditions.
Advantages of a Roth IRA
- You can withdraw the funds you contribute to your Roth IRA (the principal amount) at any time, tax-free and penalty-free if you are 59 ½ or older.
- You can withdraw funds that have been rolled over or converted from another retirement plan tax-free and penalty-free after five years.
- Distributions don’t increase your Adjusted Gross Income
- Interest, dividends, and capital gains earned inside a Roth IRA are not subject to taxation.
- If you die and your spouse becomes the sole beneficiary of your Roth IRA while owning a separate Roth IRA on her own, he or she can combine the two with incurring any penalties.
- You can pass on your Roth IRA assets to heirs.
- You are not required to take distributions from your Roth IRA based on your age.
- Since the post-tax contribution to a Roth IRA equals a larger pre-tax contribution to a Traditional IRA, you can effectively contribute more to a Roth IRA than to a Traditional IRA.
- You can use a Roth IRA to diversify tax risk.
- Distributions from a Roth IRA don’t affect the calculation of taxable Social Security benefits.
Disadvantages of a Roth IRA
- Contributions are not tax-deductible.
- You cannot use funds in your Roth IRA as collateral for a loan.
- Your eligibility to contribute to a Roth IRA depends on your income level.
- Your contributions to your Roth IRA don’t reduce your Adjusted Gross Income, which can affect your eligibility for certain tax credits and deductions.
- Contributions are taxed at your current tax bracket, which is, in most cases, higher than your tax bracket during retirement, so you’ll typically be paying more in taxes compared to a Traditional IRA.
- Should you not live to retirement or much beyond your retirement, you may not realize the tax benefits of a Roth IRA.
What is a SEP IRA?
The Simplified Employee Pension (SEP) IRA are retirement accounts provided by employers to themselves and their employees.
A SEP IRA can be set up by sole proprietors, partnerships, and corporations. Its contribution limit is significantly higher than for Traditional and Roth IRAs, and employers, not employees, make the contribution. Each employee makes their own investment decisions.
Advantages of a SEP IRA
- There are no significant administration costs for a self-employed person with no employees.
- Funds can be invested the same way as with most other IRAs.
- Contributions to a SEP IRA are tax-deductible, similar to a Traditional IRA.
- You can rollover your SEP contributions and earnings tax-free to other IRAs.
Disadvantages of a SEP IRA
- Qualified withdrawals are taxed at ordinary income tax rates after age 59 ½.
- Withdrawals before age 59 ½ generally incur a 10% tax.
What is a SIMPLE IRA?
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is another employer-provided type of IRA account and generally provides the same benefits as a Roth IRA.
Like the SEP IRA, the SIMPLE IRA is set up by an employer, who also makes contributions to the account. The employee can contribute as well and makes investment decisions.
Advantages of a SIMPLE IRA
- The SIMPLE IRA is funded via pre-tax salary reduction.
- A SIMPLE IRA can be rolled over to a Traditional IRA with a waiting period of two years after it was established.
Disadvantages of a SIMPLE IRA
- Contributions are subject to Social Security, Medicare, and Federal Unemployment Tax Act taxes.
- The SIMPLE IRA can only be established by employers with 100 employees or fewer.
- There is an early-withdrawal penalty of up to 25%.
What is a self-directed IRA?
The self-directed IRA offers all the benefits of a Traditional IRA or a Roth IRA but with one huge advantage: It allows you to invest in alternative assets. Traditional and Roth IRAs are limited to investments in stocks, bonds, mutual funds, and other paper assets (depending on your custodian). Self-Directed IRAs can invest funds in assets such as real estate, private company stock, livestock, intellectual property, and — last but not least — physical precious metals.
How does a self-directed IRA work?
For investors, this wide flexibility in investment choices offers significant benefits, most importantly the opportunity to truly diversify your portfolio. Typical IRAs are limited to paper assets, which means that when the stock market goes down in a significant manner, as it did three times in the last 20 years, their portfolio goes down too — even if it’s diversified with different stocks.
But when you own an asset such as physical gold, which is outside of Wall Street and the paper asset markets, you reduce the risk to your investments when the paper markets crash. In fact, history has shown that gold prices typically go up when stock markets go down or when inflation rises.
A Self-Directed IRA can be a Traditional IRA or a Roth IRA, so it has the same advantages and disadvantages as those accounts. But it has the advantage of being a “self-directed ” IRA, so fees will be lower since you are not paying for the management of assets, and your level of control is higher since you are in control of the IRA with no middleman.
Fortifying your IRA by investing in gold and silver
Everyone should invest for their retirement. There’s no question about that. But it can be difficult to choose between the different retirement plans and the different asset classes. What is important here is that you ultimately do what is best for your situation and benefit you and your loved ones.
Whether you have a Traditional IRA or a Roth IRA, you shouldn’t limit your investment options to paper assets. By rolling your IRA over into a Precious Metals IRA, you maintain all the benefits of your existing IRA and add the clear advantage of investing in physical precious metals.
What are the advantages gold and silver bring to your IRA?
Well, there are many benefits of owning physical gold and silver in a Precious Metals IRA, including protection against stock market volatility, financial crises, economic uncertainty, and inflation while keeping your assets out of reach of the banking industry and Wall Street. If you’d like to take a deep dive into the benefits of investing in gold, check out Gold as an Investment: The Official Guide for 2021.
Where can you get started with investing in gold and silver in your IRA?
If you’re worried about adding more complexity to your financial decision-making, we can assure you that setting up a Precious Metals IRA is easy and quick. Best of all, we will help you every step of the way so that you don’t have to worry about complicated paperwork and other logistics.
One of the reasons we have so many 5-star reviews is that our clients have peace of mind that their retirement and financial future are secured. If you would like to learn more about how we can help you achieve financial security or have any questions, don’t hesitate to call us at 888-734-7453. We can also provide information on how funds from different types of IRAs can be rolled over into a self-directed IRA, which is the Precious Metals IRA.